GDP must be priority of third program

The start of negotiations between the Greek government and the lenders over the new bailout program and the internal political developments in the ruling SYRIZA party have dominated the news lately. However, at the end of the day, the outcome of all deliberations will be judged by the ability of the Greek economy to grow in coming years. A credible agreement could contribute to this extent.

The deal struck at the eurozone summit on July 13 was based on three pillars. Greece had to deliver a set of milestones by passing packages of legislation through Parliament to obtain bridge financing and initiate talks for a new, three-year ESM program, totaling up to 86 billion euros. Greece did so and got a bridge loan of more than 7 billion euros from the EFSM facility, which enabled it to and clear arrears to the IMF and redeem Greek bonds held by the Eurosystem worth about 3.5 billion euros on July 20, avoiding default. Negotiations over the new program are ongoing but it is not easy to predict whether they will be concluded in time to allow for a bailout disbursement to pay off bonds worth 3.2 billion euros held by the ECB on August 20. If this is not possible, the country will have to get another bridge loan from the EFSM or another entity to avoid bankruptcy.

The second pillar of the summit agreement consisted of potential, additional official sector debt relief subject to Greece delivering on its commitments, following the conclusion of the first review of the ESM program. This review could take place in the fall and even later. Debt restructuring will be along the lines of the agreement reached at the Eurogroup in November 2012. It will take the form of reprofiling the Greek debt by extending maturities, providing interest holidays and perhaps converting floating interest rates into fixed. Additional debt relief has become necessary after demands by the IMF but Greece has to deliver to get it from its European lenders-partners.

The third pillar of the summit agreement is the creation of a new development fund in Greece to which public assets worth 50 billion euros could be transferred for privatization. Many doubt whether the state has these assets and the ability to produce similar privatization proceeds. The process will take many, many years and the initial plan was for part of the funding to be used for paying back ESM funds used for bank recapitalization. Another chunk will be used for debt repayment and the rest for growth initiatives.

The new, total potential bailout is estimated at between 82 and 86 billion euros. About 30 billion euros will be directed towards debt repayment to the IMF, the Eurosystem and private investors, and about 17 billion euros or so will be interest payments. Up to 25 billion euros will go towards the recapitalization of the banking sector. The rest of the money will settle arrears etc.

It is really unfortunate for a country getting ready to exit the second bailout last year to have to go through this process again. However, it is also an opportunity for both Greeks and the lenders to correct past mistakes and build on successes.

Although everybody talks about structural reforms, most fail to recognize that Greece was graded top of the class by the OECD in the overall reform responsiveness in the 2007-2014 period. They also fail to mention that the country’s ranking rose to 62nd place in the World Bank’s ease of doing business survey in 2015 from a dismal 108th in 2008. This is in addition to the tremendous turnaround in public finances, depicted in small primary surpluses in 2014 and 2013 from a primary deficit of 10 percent of GDP in 2009. A similar picture emerges from the current account and the unit labor costs.

However, all these successes have been marred by the dramatic fall in GDP and employment. Fewer people are employed today than in 2000. This is the weak point of all economic policy programs so far and has been the case despite considerable progress in reforms and the stabilization of public finances.

Undoubtedly, Greece has to undertake more structural reforms to ensure fiscal consolidation given the adverse impact of demographics on pensions, and promote competition in product and input markets to facilitate private investments and boost exports. In this context, significant debt relief should also be an upfront feature of the new program to help ease fiscal adjustment, add credibility to the country’s expected effort to access world markets in a year or two and remove uncertainty about a potential Grexit.

The cyclically-adjusted primary budget, which denotes the underlying fiscal stance, could be used in setting the new yearly targets of the ESM program to avoid imposing excessive austerity and hurt growth prospects. Moreover, the relevant authorities should move swiftly to over-recapitalize banks in order to restore confidence and ease the restrictions of capital controls on economic activity.

The new ESM program should pay more attention to growth-enhancing initiatives to be successful. In this respect, further fiscal adjustment should be minor while debt relief and efforts to restart the banking sector and boost investments and exports should take precedence. This way, the transition to the country’s new economic model, dominated by exports and investments, will speed up and the Greek economy will enter a long period of sustainable growth.

A credible bailout program can contribute to this.